Debt ceiling is a belt when we already have braces

Author

Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash University

Disclosure statement

Rodney Maddock does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

The Australian Parliament is deadlocked on a bid by the government to increase the debt ceiling from A$300 billion to A$500 billion.

The Greens have flagged a willingness to drop the ceiling entirely, in exchange for increased transparency on how government debt is being spent.

The whole notion of a debt ceiling is a new one, introduced by Labor during the financial crisis to provide scope to quickly increase borrowings if it were necessary. It is not really needed since Parliament already approves spending. The debt ceiling adds a belt when we already have braces.

In any sort of crisis, the ability of the government to borrow and use the funds to increase spending within the economy is a very important shock absorber. But of course since the borrowings have to be paid back with interest, it is simply a transfer which increases short-term spending to provide an immediate boost. Wars for example are often funded mainly by borrowing.

Government borrowing for other purposes is less justifiable. At the moment governments are being urged to borrow to invest in infrastructure. Such investment really needs to be heavily tested to check that the benefits generated by the investment will pay for the debt being raised. This sort of borrowing is particularly fraught since you and I enjoy the benefits of the investment but our children have to pay down the debt. So borrowing for infrastructure can be justified but as taxpayers and parents we should approach it with a sceptical mindset.

There are cases where increased public debt can be a good thing. But every time the government borrows more in any year than it is paying off, the overall level of public debt rises.

Since the financial crisis we have all become more sensitive to the overall level of public debt. It seems clear that governments in countries like Greece will never be able to levy enough taxes to pay down their debt. It will continue to default, by either not paying its lenders or by subterfuges such as lowering the interest rate it will pay below the rate at which the loan was written.

By getting itself into a hole like this Greece has given up its sovereign power to its lenders. The lenders are now making policy decisions that should be the exclusive right of the Greek parliament.

Australia is a long way away from that problem. In fact we have a relatively low level of debt by global standards. So our current level of debt does not threaten our sovereignty.

Spain and Italy have a different problem from that faced by Greece. They are still able to service their borrowings. But they do have to pay a much higher interest rate than other countries because their lenders are worried about their tendency to run deficits year after year. Lenders fear they are on the path the insolvency. The effect is that more of Italian and Spanish people’s taxes are going to pay off the higher interest rate than would be the case if they had a lower level of debt. In Australia some states have higher borrowing costs than others for exactly this reason.

Again the Australian government does not face this problem at present. So the Australian argument is about politics and political philosophy rather than any immediate concern about our level of debt.

But since we have a ceiling, it really does need to be raised. On current projections the debt will rise to about A$370 billion and it is clearly prudent to establish a ceiling above that. This is sensible since we really do not know what sort of emergency might arise which requires expansion of the debt.

The deeper argument is about political philosophy. Politicians like spending our money, and the problem we face as taxpayers is how to stop them. Negotiations over the debt ceiling in the US have focused attention on the tendency of debt to rise year by year, or for governments always to run deficits. France for example has not run a surplus since 1974.

Just as some people deliberately keep their credit card limits small in order to control their own lending, a borrowing limit may well be a good thing to provide some counterbalance to the politicians’ desire to spend our money. While it will always be politically inconvenient for the government in power, this is probably a healthy debate for our democracy.

This is not a trivial problem. Australia accumulated public debt in excess of the Greek levels by the Second World War. This was the result of a long period of public investment (in railways, water, ports etc), and a series of shocks (recession in the 1890s and 1930s, financing World Wars I and II), which made it hard to sell down debt. Much of it was owned to foreigners.

Australian public debt as a % of GDP

Source: Maddock, Rodney, Banks, Capital Markets and Australian Economic Development (April 30, 2013). Available at SSRN: http://ssrn.com/abstract=2258843 or http://dx.doi.org/10.2139/ssrn.2258843. The Barnard data is in the Bicentennial Statistics volume.

It then took Australia 40 years to pay down the debt to reasonable levels. Private savings were effectively repressed for forty years, mainly through negative interest rates, which diverted private savings into paying down public debt.

We may not need a debt limit, but having an ongoing debate about public debt is necessary and desirable to keep the political class honest.